The Federal Reserve’s tool for calming short-term funding markets is being tested

The Federal Reserve is struggling to persuade some banks to use a lending tool designed to improve the central bank’s control over short-term money markets.

- Matt Grossman & Sam Goldfarb

Banks have made more use of the tool, called the standing repo facility, over the past month. But there are signs some are reluctant to tap it more aggressively, which would make it easier for the Fed to maintain a firm grip on rates as it winds down shrinking its $6.6 trillion asset portfolio. At a recent private meeting, some executives told the New York Fed they worry using the facility would carry a stigma, undermining the tool’s purpose as volatility increases.

The facility allows banks to convert Treasury notes and other ultrasafe securities into cash they can borrow from the Fed overnight. That gives Wall Street firms an alternative to borrowing at higher interest rates in the market for Treasury repurchase agreements, known as repo—which in theory should help keep market rates from spiking out of alignment with the Fed’s goals.

Yet repo rates have spiked on some occasions this fall, and the tool is facing another test in the coming days, when Treasury Department auctions of tens of billions of dollars of new securities will settle. Such fund flows have lifted repo rates in the past.